Is this the beginning of the end for austerity?

The day after the Greek left-wing party Syriza impressively won the country’s latest election, the Financial Times ran the following headline:

“Greek leftists’ victory throws down challenge to euro establishment . . . Inspiration for similar parties across continent.”

It was Greece, recall, that in late 2009 triggered the European debt crisis with the revelation that its budget deficit was far worse than its official statistics indicated (the numbers had been fudged). And Greece has suffered mightily. From late 2009 to the end of 2013, its economy (gross domestic product) shrank by a punishing 25 percent. At last count (September), the unemployment rate was 25.7 percent. Among youth under 25, the rate was 49.8 percent.

Now Greece is shifting the debate again. The backlash against austerity — spending cuts, higher taxes and other policies, aimed at reducing large budget deficits and making Greece’s wages and prices more competitive on world markets — is understandable. Whether it’s realistic is, as yet, an unanswered question. What looms, as the Financial Times headline suggested, is a collision between Europe’s elites, favoring austerity, and much of the middle class, increasingly desperate and disillusioned.

Alexis Tsipras, Syriza’s leader, has proposed renegotiating much of Greece’s public debt (now estimated at 177 percent of GDP) and slowing the “privatization” of state-owned businesses. “Austerity has failed in Greece,” he wrote a few days before the election. The former government had “promised the country’s lenders that it [would] cut salaries and pensions further, and increase taxes.” Crazy, he said. Fulfilling other campaign promises, Tsipras’s government quickly announced a higher minimum wage, increases in some state pensions and plans to rehire some laid-off government workers.

The rejoinder is that austerity, though hugely painful, was beginning to succeed and trying to undo it may backfire. Jacob Kirkegaard of the Peterson Institute fears that Syriza is adopting a self-defeating “confrontational” approach toward Greece’s lenders. Greece’s economy was predicted to expand modestly, about 2 percent, in 2015. “But given the uncertainty resulting from a confrontation, these projections are worthless,” he argues.

Greece has already benefited from one debt write-down. In 2012, about 100 billion euros of debt held by banks and private investors was reduced by half, says economist Hung Tran of the Institute of International Finance, an industry research group. Maturities were also lengthened and interest rates lowered, increasing the overall debt relief.

The write-down has left most of Greece’s remaining debt with three governmental organizations — known as the “troika” — which continued lending to Greece in return for approved policies. The troika consists of the European Commission, the European Central Bank (ECB) and the International Monetary Fund. Together, they hold more than two-thirds of Greece’s government debt of 317 billion euros, says Tran.

The troika and Greece will negotiate to resolve their differences. Failure could be catastrophic for Greece. Unless Greece has a program approved by the troika, the ECB has warned that it will cease lending to the country’s banks, says Kirkegaard. Without the ECB backstop, banks would probably fail, further dragging down the economy. Lacking an agreement, the troika would also not make more loans to Greece, resulting in default on maturing borrowings. Greece might abandon the euro and restore its own currency, the drachma.

But the troika also faces limits to its power. If it is too rigid with Greece, it might fan a further popular backlash in other debtor countries, including Spain and Italy. “The pushback will be strengthened,” says Tran. A Greek exit from the euro would also create a novel situation that, conceivably, could explode into a full-blown financial crisis. On the other hand, if the troika is too lenient with Greece — admittedly, a longshot — other debtor countries might demand relief.

Austerity is on trial. There’s a huge split between those who think it is necessary medicine and those who think it is economic poison. And as Tran notes, “the fault line is getting deeper.”

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